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Fitch Rates Conagra Brands, Inc.'s Approximately $500MM Debt Issuance 'BBB'; Outlook Stable
October 10, 2017 / 2:30 PM / 2 months ago

Fitch Rates Conagra Brands, Inc.'s Approximately $500MM Debt Issuance 'BBB'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, October 10 (Fitch) Fitch Ratings has assigned a 'BBB' rating to Conagra Brands, Inc.'s approximately $500 million floating-rate senior unsecured note offering. The notes rank pari passu with its existing senior unsecured debt, and will mature in October 2020. Proceeds will be used for general corporate purposes, including the repayment of outstanding commercial paper at maturity and the repurchase of common stock. A full list of ratings follows at the end of this release. Conagra's rating recognizes the company's evolution to a business model that aligns with other large U.S. packaged food companies. Following a series of divestitures, Conagra has emerged as a pure-play portfolio of branded products. Operating margins have increased from low double-digits to mid-double-digits. The company is investing in product innovation and marketing and the results are reflected in the improved performance of its brands such as Healthy Choice. Fitch believes Conagra could stabilize sales beginning in late fiscal 2018 after several years of declines and expects the company to maintain leverage under 3x. KEY RATING DRIVERS Transition to Pure-Play, Branded Packaged Food Firm: Conagra has transitioned to a pure-play, branded packaged food company over the course of 2016 and 2017 by divesting and spinning off its private brand and commercial businesses. In July 2015, the company announced plans to sell its private label Ralcorp business (fiscal 2015 sales of approximately $4 billion and EBITDA of $370 million), which was acquired in January 2013, but had under-performed expectations. In February 2016, the company completed the sale to Tree House Foods, Inc., for $2.6 billion in cash. The company also generated approximately $489 million in net proceeds from the July 2016 sale of two of its commercial businesses, Spicetec Flavors & Seasonings and JM Swank. In November 2016, the company completed the separation of Conagra Foods, Inc. into two publicly traded companies, Conagra Brands, Inc. and Lamb Weston Holdings, Inc. (Lamb Weston), a frozen potato business which was Conagra's remaining commercial business, through a tax free spin-off. Lamb Weston generated approximately $3 billion in revenues and $593 million in EBITDA in fiscal 2016. Following the spinoff, Conagra received a cash distribution of $823.5 million and retired $1.4 billion in debt. Conagra used a majority of the proceeds from these transactions to pay down debt and ended fiscal 2017 (May 2017) with leverage of 1.9x compared to 3.6x in fiscal 2015. More recently, in May 2017, Conagra announced the proposed sale of its Wesson Oil brand for $285 million. Well Defined Acquisition Strategy: Concurrently the company defined an acquisition strategy that focuses on 'modernizing' transactions and 'synergistic' acquisitions. Modernizing transactions are smaller and consistent with emerging trends in food. Modernizing transactions are platforms for future growth but may not be immediately impactful. Conagra has closed several of these acquisitions over the past two years: Blake's All Natural Food, Frontera Foods, and Duke's meat snacks / BIGS seeds. None of these acquisitions were more than $220 million. In September 2017, Conagra announced its acquisition of Angie's Artisan Treats, LLC, a company selling popcorn and other snack items. These transactions tend to focus on premium food brands that accommodate changing consumer preferences and reorient the brand mix towards artisanal, specialty, natural and organic options. Synergistic acquisitions are larger, enhance Conagra's network and can bring new capabilities to the company. Conagra's recent acquisitions all fall into the Modernizing bucket. Margin Enhancement Initiatives Underway: Conagra's EBIT margins have grown steadily over the past two years as the company has shifted from being volume-driven to being value-oriented. Fitch adjusted EBIT margins, which were 13.8% in fiscal 2016, improved to 16.2% in fiscal 2017. In addition to resetting its volume base at higher price points, Conagra is implementing an Integrated Margin Management strategy, which focuses on mitigating inflation risk. On the operating cost front, the company completed a $200 million SG&A savings program and is on track to complete its $100 million trade efficiency program. These initiatives focus on cost-saving opportunities in procurement, manufacturing, logistics, and customer service, as well as general and administrative overhead levels. Furthermore, Conagra is working to increase margins by upgrading its portfolio. For example, the company announced the proposed divesture of its Wesson oils brand, a low margin business with significant private label activity. Customer Concentration Risk: In recent years, competition in the packaged food industry has intensified, and consolidation in the grocery and foodservice industries has led to increased negotiating power for Conagra's customers, pressuring profit margins. In fiscal 2017, Wal-Mart (including Sam's) accounted for 24% of Conagra's total net sales (in-line with Walmart's 24% food market share in North America), but no other customer accounted for more than 10% of its net sales. The grocery industry is consolidating and evolving. The pressure on food companies, like Conagra, is reflective of this consolidation and the threat of the European hard discount grocers, which focus more on private brands, entering and further investing in the U.S. market. In June 2017, Aldi announced that it would be investing a total of $5 billion over the next five years to remodel and expand its U.S. store base. Lidl opened its first U.S. store in June 2017. Walmart has responded by testing lower prices and further pressuring food suppliers, including Conagra, for better terms and lower prices. Kroger, the #2 player in the food retail industry, in turn, has stepped up its efforts to remain price competitive. The other game changer is Amazon's acquisition of Whole Foods, Inc. Currently, online grocery sales in the U.S. are in the low-single-digits as a percent of sales. However, this penetration may increase given that the Whole Foods acquisition gives Amazon a hard-to-replicate refrigerated supply chain that can be used as a base for home deliveries. In addition, Fitch expects the Amazon/Whole Foods combination to result in further downward pressure on food prices given Amazon's history of driving down prices in other industries. Leverage Expected to be Sustained below 3x: As noted, Conagra ended fiscal 2017 with leverage of 1.9x compared with leverage of 3.6x in fiscal 2015 as it used its proceeds from Lamb-Weston and the divestitures to reduce debt from $7.9 billion to $3 billion (Fitch adjusted) in fiscal 2017. Fitch assumes share buyback of $1.1 billion in fiscal 2018, based upon company guidance, which will bring leverage to mid-2x. Total leverage is expected to remain below 3x over the next 36 months, barring a significant acquisition. To the extent that Conagra does a transformative acquisition, Fitch would expect leverage to return to below 3x within the next 24 to 36 months. DERIVATION SUMMARY Over the past two years, Conagra has transitioned into a pure play, branded, packaged food company after its divestitures of its commercial businesses including Lamb Weston, Spicetec Flavours & Seasonings and JM Swank businesses along with Conagra's private label business. Concurrently the company defined an acquisition strategy focusing on smaller 'modernizing' companies along with larger 'synergistic' targets. Conagra also has implemented a margin enhancement program. The IDR upgrade to 'BBB' from 'BBB-' reflects Conagra's cost structure initiatives and a significant upgrade in its portfolio composition, which together have resulted in improved margins and higher profitability measures. Risks to the business could result if Conagra's investment in portfolio innovation does not result in a stabilization of revenue as contemplated and its margins suffer as food retailers exert more pressure on the food manufacturers than currently expected. General Mills (BBB+/ Negative) had annual revenue of $15.6 billion and was levered at 2.8x total Debt/EBITDA as of May 2017. Kraft Heinz (BBB-/Stable) had annual revenue of $26 billion, industry-leading EBITDA margin of approximately 29%, and was levered at 4.3x total Debt/EBITDA as of December 2016. Kellogg (BBB/Stable) had annual revenue of $13 billion and was levered at 3.3x total Debt/EBITDA as of December 2016. Mondelez (BBB/Stable) had annual revenue of $25.9 billion and was levered at 3.7x total Debt/EBITDA as of December 2016. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Revenue is expected to decline at a low-single-digit rate in FY2018 before stabilizing and growing at low-single-digit rates in the forecast out years. Fitch assumed yearly bolt-on acquisitions that are growing at a faster pace than Conagra's organic business; --Gross margin is expected to trend towards 32% by FY2020; --EBIT margin is expected to be maintained above 15% throughout the forecast period; --EBITDA is expected to remain steady in the $1.5 billion to $1.7 billion range; --Capex is assumed to be in the range of 3% to 4% of net sales; --FCF (after dividends) is expected to be in the range of $350 million to $400 million annually over the next 24-36 months. Fitch expects this to be directed towards the company's share buyback program but could also be used for bolt-on acquisitions; --Fitch assumed share buy-back of $1.1 billion in FY2018, which will bring leverage to mid-2x; --Total debt/EBITDA is expected to be sustained below the 3x level. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Execution of the company's strategic plan with low-single-digit organic growth that is in line with, or better than category growth with overall market shares stable or improving and operating margins remain in line with the industry average in the mid-teens or above; --Leverage (Total debt/EBITDA) sustained below 3x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --The company loses momentum, leading to sustained top-line weakness and potential market share loss in major categories; --Leverage moving toward mid-3x as a result of poor performance, material debt-financed share buybacks or acquisitions. LIQUIDITY Ample Liquidity, Manageable Maturities: Conagra maintains an undrawn $1.25 billion senior unsecured revolving credit facility that provides backup for its commercial paper program. The company had $323.2 million outstanding in its CP program and $251.4 million cash as of Aug. 27, 2017. The majority of this cash, $244.5 million, was held in foreign countries. Total debt was approximately $3.3 billion as of Aug. 27, 2017. FULL LIST OF RATING ACTIONS Fitch currently rates the company as follows: Conagra Brands, Inc. --Long-Term IDR 'BBB'; --Short-Term IDR 'F2'; --Commercial Paper 'F2'; --Senior unsecured credit facilities 'BBB'; --Senior unsecured notes 'BBB'; --Subordinated notes 'BBB-'. The Rating Outlook is Stable. Contact: Primary Analyst Ellen Itskovitz, CFA Senior Director +1-312-368-3118 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Monica Aggarwal, CFA Managing Director +1-212-908-0282 Committee Chairperson Hoai Ngo Senior Director +1-646-582-4603 Date of Relevant Rating Committee: Oct 4, 2017 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and restructuring costs. For example, Fitch added back $36.1 million in non-cash stock-based compensation and $308 million restructuring related costs in 2017. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com. 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